Current TSP Allocation and Business Cycle Phase Update – November 2014

Thrift Savings Plan monkey

11/25/2014

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

Happy Thanksgiving, especially to our colleagues who are overseas and away from home and family during this holiday season.

Another month has gone into the books and the US economy continues to strengthen in a long, slow recovery. I am running much later than I should be again this month and will not get to write about everything I would like, but will discuss why I am remaining 100% in the S Fund for now, the increased TSP contribution limits for 2015, economic and business cycle phase indicators, and some very good opportunities I am investing in outside of the Thrift Savings Plan.

Bottom line up front: my current TSP allocation remains 100% in the TSP S Fund (this reflects both my contribution allocation as well as where my existing balances are invested). TSP Allocation Guide Performance through market close on 11/24/2014: Year to Date:  7.45% Year to date TSP fund performance:

  • TSP C Fund:  14.12%
  • TSP S Fund:   7.45%
  • TSP I Fund:    -1.55%
  • TSP G Fund:  2.10%
  • TSP F Fund:  6.01%

Why has the C Fund done better than the S Fund this year (and why haven’t you switched yet)?

The are a number of non-business cycle explanations for why the C Fund may have outperformed the S Fund in 2014, and I believe a combination of these factors explains the C Fund’s edge:

  • the Spring correction in biotech stocks, which disproportionally impacted the S Fund and set us back several percentage points;
  • the very strong performance of the S Fund over the past few years, which has made small caps stocks very expensive relative to large caps (overvalued in Wall Street lingo). This outperformance by the small caps was good for us the past few years as the S Fund has crushed the C Fund since the start of the current bull market, but eventually valuations have to return to something approximating their historical relationship;
  • the “strong dollar trade” which is a pattern in which large cap stocks tend to do better relative to small caps when the dollar strengthens as it has dramatically over the second half of the year.

The other possibility is, of course, that we have reached the end of the recovery phase of the business cycle and as a result are entering the phase during which the C Fund will typically perform best. Some of our key indicators may point us toward this possibility:

  • we have entered the top end of the full employment range, so even as unemployment continues to drop, that may not be as meaningful as it was earlier in the recovery;
  • the Fed has signaled that it will start to raise interest rates, likely in 2015. While interest rates aren’t rising yet, the market may well be anticipating the rise and this indicator may be lagging.

While there are a lot of statistics to back up the business cycle theory of investing, it is really more art than science at decision points such as this one. There is no formula which I can plug numbers into which gives me the answer. I have gone back and forth over the past few months and was very close to going to 50% each S Fund and C Fund on more than one occasion. I haven’t yet because during the brief periods in 2014 when the non-business cycle factors described above were not in play, I believe the S Fund has outperformed the C Fund. And I haven’t tried to trade in my TSP based on those non-business cycle factors because in my experience those are too speculative, too short-lived and too unpredictable. I am much more comfortable with my long-term approach. (A reader recently pointed out that I need to do a better job of breaking out the business cycle phase indicators from the recession risk indicators, and I plan to do that in future updates as I continue to try to make this a more useful tool. Thanks for the suggestion.)

TSP Contribution Limits:

For those of you who are able to maximize contributions (and that should be everyone’s goal because the tax savings really make this an unmatchable opportunity), the Thrift Savings Plan elective deferrals contribution limits have been raised from $17,500 to $18,000 for 2015. Catch-up contributions have also been raised, from $5500 to $6000. Assuming you are a typical Fed and are paid bi-weekly, the first pay period for 2015 contributions is Pay Period 25. There are 26 pay dates in 2015, so $18,000/26 = $692.31; round up to $693. (TSP.GOV worksheet here.) You can change that now on your Employee Personal Page.

 

My view of the markets:

There is nothing in the economic data which I will detail below to make me believe that the medium and long term direction of the stock market is anything but up. The market has been doing so well over the past six weeks that I believe there is an excellent chance we will see a small correction at some point before the end of the year, but overall I expect that December and January will largely live up to their past as the strongest two months of the year. Low oil prices and actions taken by Europe and Japan to stave off recession should continue to bolster the US markets and make up for the end of Quantitative Easing.
Earnings season is pretty much wrapped up and it has been a good one. Of the 445 companies in the S&P 500 which have reported so far, 332 beat expectations, 73 missed and 40 met. In the long term, stock (and therefore stock market) valuations are based on earnings, so this is a good ratio for us to see.

 

October Economic Numbers As always, I will run through the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me (these indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle):

Third Quarter GDP came in at a very healthy 3.9%, higher than nearly all estimates. The GDP number was boosted by a large increase in defense spending during the quarter. Combined with the second quarter GDP, this is the strongest six month period since 2003.

3Q GDP Growth - TSP Allocation Guide Employment numbers: the October 2014 jobs numbers were again very solid and we have now reached the longest private sector job growth streak in US history. I obtain this data from the Bureau of Labor Statistics:

Total nonfarm payroll employment rose by 214,000 in October, and the unemployment rate edged down to 5.8 percent. Employment increased in food services and drinking places, retail trade, and health care. Both the unemployment rate (5.8 percent) and the number of unemployed persons (9.0 million) edged down in October. Since the beginning of the year, the unemployment rate and the number of unemployed persons have declined by 0.8 percentage point and 1.2 million, respectively.

October 2014 Unemployment Rate Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report. Any number above 50 indicates economic growth, and this month’s reading of 59 is very high:

Economic activity in the manufacturing sector expanded in October for the 17th consecutive month, and the overall economy grew for the 65th consecutive month. The October PMI® registered 59 percent, an increase of 2.4 percentage points from September’s reading of 56.6 percent, indicating continued expansion in manufacturing. The New Orders Index registered 65.8 percent, an increase of 5.8 percentage points from the 60 percent reading in September, indicating growth in new orders for the 17th consecutive month. The Production Index registered 64.8 percent, 0.2 percentage point above the September reading of 64.6 percent. The Employment Index grew for the 16th consecutive month, registering 55.5 percent, an increase of 0.9 percentage point above the September reading of 54.6 percent. Inventories of raw materials registered 52.5 percent, an increase of 1 percentage point from the September reading of 51.5 percent, indicating growth in inventories for the third consecutive month. Comments from the panel generally cite positive business conditions, with growth in demand and production volumes.

The following table shows the progression of the PMI over the last year: Oct 2014 12 month PMI Yield spreads: I obtain my data for this section from the Cleveland Federal Reserve. This month the Cleveland Fed noted:

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate that the expected chance of the economy being in a recession next October at 3.42 percent, up from September’s number of1.99 percent and above August’s number of 2.76 percent. So although our approach is somewhat pessimistic with regard to the level of growth over the next year, it is quite optimistic about the recovery continuing.

The below chart shows the historical probability of recession based on where the yield curve is now: Recession probability from yield curve October 2014 TSP talk Money supply growth: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) continues to expand. I obtain this data from the Federal Reserve.

Money Supply M2 in the United States increased to 11422.4 USD Billion in July of 2014 from 11351.40 USD Billion in June of 2014.

October 2014 M2The stock market: a trailing indicator as it relates to the economy for the most part, but worth tracking on a monthly basis for signs of significant disruptions. We are setting all-time highs nearly every day, which is good news because highs beget more highs. S&P 500 one year chartSo again, all of the indicators are pointing in the same direction, and I believe that we remain in the Recovery Phase of the Economic Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing. For that reason, I remain 100% invested in the TSP S Fund.

The Other TSP Funds

TSP C Fund: The C Fund will likely perform just fine and roughly parallel to the TSP S Fund, but historically the S Fund will outperform in this phase of the economic cycle. That said, if someone wants to, it probably won’t make much difference to split allocations between the two. In my non-TSP investing, I have started to focus more on large cap ETFs as I believe we are on the cusp of changing phases.

TSP I Fund: Japan has dipped into recession (although I am inclined to believe that it will be shallow and short-lived) and Europe is right on the edge of recession and deflation. If you subscribe to the “buy when the blood is in the streets” theory, it is either time, or soon will be time, to buy before both economies turn positive and the markets roar back. I’m not convinced we are to that point yet, and I think that positive returns from US stock markets are more predictable. I might miss out on a few percentage points if the I Fund really takes off, but in my estimation it is just as likely to go lower first.

TSP F Fund: I expect flat to negative returns for the TSP F Fund until interest rates go up and stabilize (see the F Fund vs G Fund post for the details on why that will happen). But that’s what we said at the beginning of the year and interest rates surprised everyone by staying low. Eventually that has to give and the F Fund will suffer.

TSP G Fund: The TSP G Fund would be my safe haven of choice these days, if I needed a safe haven.

TSP L Funds (the lot of them): If an investor just doesn’t want to bother looking at things for 40 years, an L Fund would be better than the default TSP G Fund. But I believe we can do better than the mediocre-to-average returns which the L Funds are engineered to achieve.

Individual stock picking for fun (and occasional profit)

thrift savings plan_sleeping_dog_moneyDisclaimer: This non-TSP talk is for fun, not at all a recommendation to buy. The vast, vast majority of my investments outside the Thrift Savings Plan are in great big index funds, not individual stocks. While I have had some great winners over the years, overall I would have been much better off if I had put all of the money I have invested in individual stocks into those index funds. So this is Vegas money, just for fun. Really.

Periods like the last few months are dangerous for me because they make me believe I can really pick stocks and I haven’t just gotten lucky. Apple (AAPL) remains my largest individual holding and has gone on a great tear since mid-October (it is time for me to take some profits and get that to a smaller portion of my non-TSP investments). And I absolutely couldn’t have timed my purchase of Visa (V) any better – it is up 20% since I bought it in October. But I am smart enough to know that was pure dumb luck – I would have been happy with anything over 10% over the next year on Visa.

I currently believe there are some good opportunities out there right now in (1) emerging markets and (2) oil related stocks. I have started to build a position in VWO, which is Vanguard’s emerging markets ETF.

Emerging markets have been beaten down over the past few years, so much so that they are really the only major sector below fair value. And they are showing signs of making a comeback, with India and Indonesia both selecting economy-first candidates in their recent elections. I chose VWO because the emerging market ETFs largely track the same countries and stocks, and Vanguard’s offering has the lowest expense ratio.

Plunging oil prices have hit shares in oil companies and oil service companies hard. I am not convinced that oil prices have hit bottom (I think OPEC will have to cut production to stabilize prices before that happens), but I will start to build a position in Chevron (CVX) which is my favorite of the major oil companies over the next few months. Chevron is well managed and has a lot of production coming online over the next five years, so it is well positioned to do well as this very cyclical sector rotates back into favor. It also has a dividend yield of 3.64% and has grown dividends for 28 straight years.

And my current favorite is Magellan Midstream Partners (MMP). Magellan has been caught up in the general decline in oil related stocks, which just goes to show how stupid and inefficient the stock market can be. Magellan’s main business is delivering refined oil products up the middle of the United States, delivering gas from refineries to the terminals where it is loaded into the tanker trucks which deliver it to the gas stations. Magellan actually benefits from lower oil prices because they are paid based on throughput – lower oil prices means more demand for that cheaper gas, which means they pump more and get paid more. I believe Magellan will bounce back strongly as it continues to report strong earnings, and the 3.16% dividend won’t hurt in the meantime. Because it is structured as a master limited partnership, it does make your taxes slightly more complicated and it is generally not suitable for holding in a tax advantaged account such as an IRA. It is way too complicated for me to get into here, but for an explanation you can see this Investopedia page on master limited partnerships.

The Next Update

I will update this post again during the second week of next month after all of this month’s data comes in unless something shocking happens which requires me to send out a new update. I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I have stumbled across for investors, Feds and the military once or twice a day at: @TSPallocation

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13 thoughts on “Current TSP Allocation and Business Cycle Phase Update – November 2014”

  1. News to the feds and TSP investing. So your insight is much appreciated. I was going to ask about starting to buy into the I fund but was hesitant because I want to wait till it is as low as it will go. When it improves do you think the returns will be as good as the C and S fund?

    1. If the I Fund gets a good run, I would expect it to outpace the S Fund and C fund (which I tend to think will have more historically typical returns over the next few years because the big stock market growth tends to come at the beginning of recoveries, not when the economy is at full strength. But the I Fund is a much more complicated beast, so it is much harder for me to develop a solid rationale for when to make the decision to invest.

  2. Thank you once again for your insights. You make a compelling argument for staying 100% in the S fund. Up until last month I was similarly invested but sensing the start of a general market rotation into large cap stocks I am now at 50/50 S &C funds.
    Also, would you agree that when interest rates are hiked next year, this will have less of a negative effect on the large caps vs. small caps?

    1. I absolutely agree. Rising interest rates are definitely one of the key factors which result in the relative strength of large caps compared to small caps historically, which is why that is one of the indicators I look at while trying to gauge when the business cycle phase is shifting.

    1. There are 26 pay dates which is actually what matters in calculating your TSP elective deferrals. Sorry I wasn’t clear about that above – I will put in an edit.

      1. Hi Paul,

        I contacted you about a month ago regarding *when* to make the bump effective for a person’s first 2015 deferral. I’m with the USPS, so John is correct about there being 27 pay *periods,* but you’re saying there are 26 pay *dates.* I’m really confused right now; postal employees just received a letter in the mail saying to divide the $18k by 27. I made multiple phone calls and no one seemed to have a concrete answer. Human Resources is sticking to their story of $667 per paycheck. Any thoughts/clarity on this mess?

        Much thanks.

        1. Let me do some double checking. I suppose it is possible that some agencies with different pay systems (USPS and DFAS) could have different pay dates than “normal feds.” Or maybe my HR folks put out bad jnfo.

          1. Aware of how busy you are; really appreciate you chasing down any potential info. Amazing that there isn’t any cut and dried definitive math for each respective agency. Curious to see what you come up with.

            Thanks as always for all your efforts, insight and information.

  3. Thank you for creating this blog. I always welcome advice from someone who doesn’t seem to have much to gain other than the personal satisfaction of helping others. My only question is if you decide this effort is too time consuming will you be letting us know? If you are dedicated to this how long do you think you’ll stick with it (years)?

    Thank you!

    1. Thanks for reading. If I ever do decide to stop I will certainly let everyone know and perhaps try to figure out a way to pass the baton off to someone who has a similar investing strategy and temperament. I suspect that if I feel that it is taking up too much time because of work or family, the updates will just start looking a lot more like they did in the October update which was much shorter and didn’t have all the pretty charts. I haven’t really thought about how long I will keep doing this, but no plans to stop any time soon.

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